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COST MANAGEMENT BASICS COST PLANNING

COST MANAGEMENT BASICS COST PLANNING. Agenda. Explanation of Cost & Cost Planning Computing Rates Measuring Performance Master Data Identifying Requirements & Forecasting Benchmarking Establishing Operational Requirement Levels Setting Cost Targets

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COST MANAGEMENT BASICS COST PLANNING

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  1. COST MANAGEMENT BASICS COST PLANNING

  2. Agenda Explanation of Cost & Cost Planning Computing Rates Measuring Performance Master Data Identifying Requirements & Forecasting Benchmarking Establishing Operational Requirement Levels Setting Cost Targets The Role of Budgeting in Planning and Control Managerial Performance Reports

  3. Explanation of Cost & Cost Planning

  4. Capture and Valuate Data • Accurate, timely and relevant data • Connecting operational output/performance data to financial data • Allocate Overhead Cost Accounting • Cost Planning • Set Cost Targets and Efficiency Goals • Compute Standard Rates Cost Planning Cost Analysis Cost Management Process • Cost Analysis • Variances • Depreciation • Trends and forecasting • Product, service or activity cost by element (labor, contract etc) • Understanding full costs of organizations, operations, products and services Cost Controlling • Cost Controlling • Move to action based on analysis • Change targets • Change resources • Change quality Cost Management Involves

  5. Amount of resources given up in exchange for some goods or services The amount of expenditure (actual or notional) incurred on, or attributable to, a specified thing or activity A foregoing, measured in monetary terms, incurred or potentially to be incurred to achieve a specific objective Discussion: What does cost mean to you? At home? Water, cable, phone bill To your organization? Maintenance, services, IT contracts What is cost?

  6. Basic elements of cost: Raw materials Labor Indirect expenses/overhead What is cost?

  7. Cost = Converting and Measurement of Work Cost Center Asset / Equipment Project / Program Internal Order WBS / Work Order Organization - Labor, Materials, Supplies Resources/Inputs Plant, Property & Equipment Building Project, Weapon System Outputs Services, Events (SSP, Course) Job (Set of Tasks) – Maint & Repair 7

  8. Cost Planning Cost Planning is the use of a Cost Model for “should-cost” forecasting to make informed decisions • Often Performed for: • Budget Requirements Requests • Costs Estimations • Output Quantities • Capacity Management • Risk Analysis • Various Time Frames: Out year / Current year, Quarterly, Monthly • Standard Rates • Defining Targets to Measure Efficiency and Effectiveness Cost Accounting Cost Planning Cost Analysis Cost Management Process Cost Controlling

  9. What is Cost Planning? • A cost plan determines the fiscal feasibility of an initiative. This is done by setting the lifecycle budgets and cost controls to manage the delivery and quality of the initiative's outcomes over a set timeframe. • Cost Estimating and Cost Planning are not the same • A cost estimate is an assessment or approximation of the likely costs of an initiative with an indication as to the degree of accuracy, usually +/- percent. • In the construction industry—a good example of project management—a cost estimate is a prediction of the costs of construction.

  10. Cost Planning Example • In the construction industry, a cost plan is used as a way of controlling the estimated costs during the design and construction phases of a project. • Cost plans are living artifacts, just like project management plans. They must be managed throughout the lifecycle of any initiative in any industry.

  11. How to cost plan • Art or science? • Sound commercial principles dictate how cost estimation migrates into cost planning • right modeling tools • experience

  12. Time is money Risk and reward are opposites. The higher the risk, the greater potential for reward. If the risk is unsustainable, there'll be no reward. Appropriate controls to develop, implement and manage cost estimates and cost plans are the key to repeatable quality outcomes and commercial success. Cost estimating and cost planning outcomes provide the framework for cost control through the lifecycle of any initiative. Guiding Principles

  13. Successful cost planning is made up of diversified choices in approach and execution. There is no one approach that fits all scenarios. Making the best and most appropriate choices to fit the situation. Before developing the cost plan for any initiative, you need to consider the framework. There are decisions that need to be made in order to determine the best approach for your cost plan and deliver the desired outcome and accuracy. Cost Planning Highlights

  14. Decisions to be made when determining the best approach: What is being planned? The principles are the same but the environment, approach and tolerances will be different. Is the opportunity a deal or a contract? A contract may have penalties for non-performance or delays. A deal is more of a partnership. Do I need to test the market with an RFI or RFP/RFT/RFQ? What is the commercial envelope? Is it a fixed lump sum, target sum, open book, or other? Has there been a sound assessment of the risk versus the complexity? What is the degree of confidence and/or accuracy? Do I need to obtain market coverage to sharpen the accuracy? Is there a comprehensive work breakdown structure (WBS) for services and materials? Do I have a strong understanding of the concept of money and the methods to determine the investment value or the return on investment? What about developing present and future value-of-money models? How does time affect the proposed cost plan? Is risk covered and are there adequate contingencies? What is cost planning?

  15. The success formula for repeatable execution of quality cost estimates and cost plans is a combination of experience, commercial intellect, optimal choices of tools, and approach. Cost estimating and cost planning are both an art and a science. But most importantly, they require a strong dose of structure and discipline. And never underestimate what experience brings to the table. Cost Planning Summary

  16. Planning vs. Actual Data • Cost Planning aims to be predictive and to inform operational decisions. • Cost Planning is necessarily speculative and approximate to some degree—variances in cost and other variables will always exist.

  17. Starting Point: The Plan (Budget) • Just as in analyzing volume and performance variance we must start with an expectation • This is the plan or budget • The plan or budget must define two of the following three variables in the equation: cost = output x cost per output • Some measure of output (like units) • A measure of cost per output • The total cost • Furthermore, the plan defines these variables for all time periods or milestones within the project

  18. Computing Rates

  19. What is a rate? Basic Definition: a quantity measured with respect to another measured quantity Miles per hour (mph) $ per gallon (gasoline, etc.) $ per kWh (kilowatt-hour; i.e. your electricity bill) Calories per serving Specific definition for our purpose: the cost per unit of a commodity or service $ per hour for electrician (i.e. DPW work at an installation) $ per hour for depot maintenance work (i.e. AMC) Computing Rates

  20. Your water bill (i.e. cost per gallon of water) Primary considerations: Number of customers Forecasted total consumption; consumption per customer Equipment costs Labor costs Other considerations: Planned maintenance (replacing aging pipes) Unplanned maintenance (replacing damaged pipes) Rent/leasing a house ($/month) Primary considerations: Mortgage costs (includes: principal, interest, insurance, taxes, etc.) Utilities Homeowners Association dues Maintenance costs Rental market comparables Profit Other considerations Unplanned maintenance (refrigerator dies) Unrented periods Computing Rates Examples

  21. Army rates discussion: For most Army organizations, labor is the predominant resource used and is the key component for most services Therefore, the ability to accurately estimate and project labor costs is absolutely essential to help managers make informed operational and cost decisions Standard labor rates provide managers with a tool for developing estimates of current and future labor costs Computing Rates

  22. Standard cost is any cost computed with the use of pre-established measures Standard costing is a costing method that attaches cost-to-cost objects based on reasonable estimates or cost studies and by means of budgeted rates rather than according to actual costs incurred A standard labor rate is the total value of costs planned for a workforce divided by the planned annual productive hours available for that workforce (planned labor dollars / planned productive hours). Stabilized labor rate is the standard labor rate established for a depot or other working capital fund activity and is a cost per direct labor hour (or other output measure) customers are charged for the products and services provided by a depot or activity group. Labor Rates

  23. AMC charges standard rates for depot maintenance work, and ATEC uses standard rates when charging customers for test and evaluation support. It is imperative these rates include all the components of the full (AMC) or reimbursable (ATEC) cost incurred by these organizations when performing work for customers. Organizations should not only be able to identify direct costs, but also indirect costs when formulating rates. For example: ATEC includes overhead costs in the rates charged to non-DoD customers. Labor Rate Example

  24. Establishing Standard Rates • Standard labor rates are based on documented labor and service (production) costs from previous fiscal years. • These historic costs are adjusted for inflation, anticipated productivity changes and other factors that are expected to impact costs in the next fiscal year. • The inclusion of leave within the Std. Rate is required to accurately associate the cost of work performed to the receiver cost object. Leave hours should be associated with the organization owning the resource, not charged to products/services, customers, or programs.

  25. Establishing Standard Rates(cont.) • The organization must accomplish the following to establish the standard labor rates (next slide): • Divide the organization into resource (cost) pools. • For each resource pool, determine the total pay and benefits paid over the course of the fiscal year. • For each resource pool, determine the total number of available work hours for the fiscal year. • Note that this is not the number of hours for which employees were paid. It is the number of hours for which they were present for work. Leave is utilized within the determination of the productive work hrs available. • Divide total pay and benefits by the number of available work hours to establish the actual historic labor rate. Adjust this historic rate by factoring in inflation, anticipated productivity changes, and other factors expected to impact labor costs in the next fiscal year. This is the standard labor rate for a resource pool.

  26. GFEBS Standard Rates Example

  27. Measuring Performance

  28. Performance Measurement Performance measures describe how well an individual has performed a task A good performance measure reveals the actions of the individual being evaluated Motivates individuals to act in the organization’s best interest and Cultural differences influence performance measurement

  29. Performance Measurement Certain aspects of financial accounting systems exist today because of the demand for performance measures Multiple performance measures generally will reveal an individual’s actions more accurately than a single measure

  30. Example Performance Metrics

  31. Example Performance Metrics

  32. Units produced Input used Productivity = Productivity • Measure of process improvement • Represents output relative to input • Only through productivity increases can our standard of living improve

  33. Units produced Labor-hours used Productivity = 1,000 250 = = 4units/labor-hour Productivity Calculations Labor Productivity One resource input  single-factor productivity

  34. Output Labor + Material + Energy + Capital + Miscellaneous Productivity = Multi-Factor Productivity • Also known as total factor productivity • Output and inputs are often expressed in dollars Multiple resource inputs  multi-factor productivity

  35. Old System: Staff of 4 works 8 hrs/day 8 titles/day Payroll cost = $640/day Overhead = $400/day New System: 14 titles/day Overhead = $800/day Collins Title Productivity

  36. Old System: Staff of 4 works 8 hrs/day 8 titles/day Payroll cost = $640/day Overhead = $400/day New System: 14 titles/day Overhead = $800/day 8 titles/day $640 + 400 Old multifactor productivity = Collins Title Productivity = .0077 titles/dollar 14 titles/day $640 + 800 New multifactor productivity = = .0097 titles/dollar

  37. Measurement Problems Qualitymay change while the quantity of inputs and outputs remains constant External elements may cause an increase or decrease in productivity Precise units of measure may be lacking

  38. Preferred Performance Measures • Preferred Performance Measures are those that are sensitive to or change significantly with the manager’s performance. • They do not change much with changes in factors that are beyond the manager’s control • They motivate the manager as well as limit the manger’s exposure to risk, reducing the cost of providing incentives • May include Benchmarking

  39. Performance Measures at the Individual Activity Level • Two issues when evaluating performance at the individual activity level: • Designing performance measures for activities that require multiple tasks • Designing performance measures for activities done in teams

  40. Master Data

  41. An Activity Type represents a group of resources within a Cost Center. These resource groups have capacity and a unit of measure such as: labor hours, machine hours, square footage, etc. Activity Type Uses: Capture Capacity or Planned Output Example: technician works 2088 Hrs or machine runs 3500 Hrs (10 Hrs/Day for 350 days) Holds the rate for the output of the resource pool Example: $2 Hr, $5 Hr, $20 Hr Assigns capacity consumed by products/ services Example: Hrs/min worked per diagnostic test, which then valuates based on the rate Master Data: Activity Types

  42. Various other cost objects are used to represent the things that the Cost Centers/Orgs are providing: Internal Orders, Projects/Work Breakdown Structures, Maintenance Orders, etc. Internal Orders: are short term in nature, represent an event or job, do not replace the rigor of the Project/WBS Element structure Example: Courses, CLS-SSPs, Pre-Deployment, Professional Certification WBS Elements: sub-tasks within Projects used for planning, executing, and costing and managing dependencies Example: MEDCOM MRMC Labs projects, DPW Minor Constructions, Environmental clean-ups. Additionally, WBS Elements are used for reimbursable work either through a MIPR or as a Direct Charge. Business Process: Captures costs of cross-functional activities (the “work” performed by the Cost Center/Activity Types) and typically related to an action such as a “verb” Example: Pick Items, Pack Boxes, Ship Pallet Master Data: Things You Do

  43. A Statistical Key Figure (SKF) is a piece of information about the cost object it is assigned to Example: # FTE for a cost center, # of telephones, # of Students in a Class, # of Ads within a Campaign SKFs are used to: Capture non-financial information Calculate the basis (cost driver) for cost assignments Example: # of telephones to allocate out from the phone bill Measure performance Example: # of tests SKF can plan for the year and then actuals captured to report progress Calculate a unit cost rates Master Data: Things You Track

  44. Identifying Requirements& Forecasting

  45. Quality Function Deployment • Identify what customer wants • Identify how the good/service will satisfy the customer wants • Relate customer wants to product how’s • Identify relationships between the firm’s how’s • Develop customer importance ratings • Evaluate competing products • Compare performance to desirable technical attributes

  46. QFD House of Quality

  47. ?? What is Forecasting? • Process of predicting a future event • Underlying basis of all business decisions • Production • Inventory • Personnel • facilities

  48. Forecasting • Forecasts are critical inputs to business plans, annual plans, and budgets • Finance, human resources, marketing, operations, and supply chain managers need forecasts to plan output levels, purchase services and materials, workforce and output schedules, inventories, and long-term capacities • Forecasts are made on many different variables • Forecasts are important to managing both processes and managing supply chains

  49. Seasonal peaks Actual demand line Demand for product or service | | | | 1 2 3 4 Time (years) Components of Demand Trend component Average demand over 4 years Random variation

  50. Trend Component • Persistent, overall upward or downward pattern • Changes due to population, technology, age, culture, etc. • Typically several years duration

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